Mean-Variance Analysis

What is a 'Mean-Variance Analysis'

A mean-variance analysis is the process of weighing risk (variance) against expected return. By looking at the expected return and variance of an asset, investors attempt to make more efficient investment choices- seeking the lowest variance for a given expected return, or seeking the highest expected return for a given variance level.

Mean variance analysis is a component of modern portfolio theory, which assumes investors make rational decisions, and that for increased risk they expect a higher return.

BREAKING DOWN 'Mean-Variance Analysis'

There are two major factors in mean variance analysis: variance and expected return.

If two investments have the same expected return, but one has a lower variance, the one with the lower variance is the better choice.

By combining stocks with different variances and expected returns in a portfolio (diversification), the variance and expected return of the portfolio can be altered as the price moves of one stock may be offset by the price moves of another in the portfolio.

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RELATED FAQS
  1. Is variance good or bad for stock investors?

    Learn how high variance stocks are good for some investors and how diversified portfolios can reduce variance without compromising ... Read Answer >>
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    Learn about expected return and variance, the difference between the two measures and how to calculate the expected return ... Read Answer >>
  3. How can I measure portfolio variance?

    Find out more about portfolio variance, the formula to calculate portfolio variance and how to calculate the variance of ... Read Answer >>
  4. What is price variance in cost accounting?

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